This 16-Minute Video Will Teach You Exactly What to Do With a Losing Options Trade.

Key Concepts

• Put Spread: An options strategy involving selling a put at a higher strike price and buying a put at a lower strike price to collect a net credit.
• Delta: A measure of an option's price sensitivity to changes in the price of the underlying asset.
• Probability of Touching: The statistical likelihood that an underlying asset will reach a specific price level at some point before the option's expiration.
• Rolling: Closing an existing position and opening a new one with a different expiration date or strike price.
• Defending: Adding a secondary, opposing position (e.g., a call spread against a put spread) to offset risk and reduce the net cost basis of a losing trade.
• In-the-Money (ITM): When an option has intrinsic value because the stock price is unfavorable relative to the strike price for the option holder.

Managing Losing Trades: A Four-Choice Framework

The speaker, a trader with over 35 years of experience, emphasizes that losing trades are an inevitable part of the business. When a trade moves against the trader, they are presented with four distinct strategic choices.

1. Holding the Position

• Rationale: If there is significant time remaining until expiration (e.g., 45 days), the trader may choose to wait for the stock to recover.
• Evaluation: Traders should look at the "probability of touching" the strike price. If there is a high statistical probability (e.g., 78%) that the stock will rally back to the strike price, the trade may still have a chance to become profitable or at least reduce the loss.

2. Closing the Trade

• Rationale: This involves buying back the spread to exit the position entirely.
• When to use: This is appropriate if the original thesis for the trade is no longer valid.
• Risk Mitigation: Closing the trade prevents further losses. For example, if a spread is currently worth $3.00 but has a maximum loss potential of $5.00, closing it now limits the loss to the current market value, avoiding the risk of the loss growing as expiration approaches.

3. Rolling or Adjusting

• Methodology: This involves closing the current position and opening a new one at a different strike or expiration date.
• The "Credit" Rule: The speaker advises against rolling if it results in a debit (paying money to move the trade). He prefers to roll only if he can maintain a credit.
• Decision Criteria: The trader asks: "Would I enter this new position if I didn't already have a trade on?" If the answer is no, the adjustment should not be made.

4. Defending the Trade

• Methodology: This involves adding a new, opposing position to hedge the original trade.
• Example: If a trader is short a put spread (bullish, positive delta), they might sell a call spread (bearish, negative delta) against it.
• Outcome: This generates an additional credit, which lowers the overall cost basis of the position and provides a buffer against further downward movement in the stock.

Strategic Insights and Best Practices

• Pre-Trade Planning: The most effective traders decide on their "exit" or "defense" strategy before entering the trade. This removes emotional decision-making during market volatility.
• Nuance of Time: The strategy for a losing trade changes based on the time remaining. A trade with 45 days to expiration requires a different approach than one with only 18 or 25 days remaining.
• Mechanical Consistency: While there is no "best" choice, traders should aim to be mechanical. By having a pre-defined set of scenarios, a trader can process losses quickly and move on to the next opportunity without unnecessary stress.

Conclusion

There is no single "correct" way to handle a losing trade. The choice between holding, closing, rolling, or defending depends on the trader's risk tolerance, the time remaining until expiration, and the current market volatility. The ultimate goal is to move from reactive, emotional decision-making to a systematic, pre-planned approach that manages risk effectively.

Disclaimer: The speaker notes that these strategies are for educational purposes and do not constitute financial advice. Traders should always assess their own risk tolerance before executing any strategy.